FHA 203k and Fannie Mae Homestyle loans have traditionally been the only solutions for a home buyer looking to finance both the cost of purchasing AND renovating a fixer upper.
But today, that’s no longer the case and mortgage bankers will often avoid suggesting FHA 203Ks and Homestyle loans to their clients, and realtors are frequently steering both their buyers and sellers away from these types of loan completely.
And while most of the time they’re used for building a home from the ground-up, the same applies to construction loans, given that they can also be used for renovating a property.
Well there are four primary reasons that apply to these loans, and in this guide, we’re going to dive deep into these and introduce you to an alternative; RenoFi Loans, as well as looking into the appeal behind buying a fixer upper house.
Specifically, we’ll take a look at:
An FHA 203k Loan, Fannie Mae HomeStyle loan or a construction loan might not be the best way for you to purchase and renovate a fixer upper.
Speak to a RenoFi Advisor today to talk through your options.
The Appeal of Buying a Fixer Upper
While it’s nice to buy a move-in ready home, there are tons of benefits to picking a home that needs some work. In a tight real estate market, it can be difficult to find a home that fits your lifestyle and budget at the same time.
So why not expand your search to properties that you can make your own?
Purchasing a fixer-upper allows you to potentially save money and tailor a home exactly to your needs. Rather than spending more on a home that doesn’t require any repairs, you can pay less and hire a professional to do the repairs with the money you’ve saved.
According to a 2019 study by Realtor.com, “nearly 60% of home buyers aged 18-34, many of whom may be buying for the first time, say they’re open to a house that needs renovations.”
And this perhaps comes as no surprise, given that the housing market is becoming increasingly competitive. House prices are on the rise, inventory is low and first time buyers are facing tough competition on move in ready homes.
Increasingly often, they’re turning to fixer uppers as a way to get onto the property ladder.
But that’s not the only reason why fixer uppers are a popular choice right now, with many home buyers looking for the perfect property that they can buy cheap, renovate and turn into their dream house.
When we then consider that finding the right property is one of the hardest parts of buying a house, it makes sense to consider these properties when house hunting.
In fact, buying and renovating a fixer upper comes with a number of benefits:
You’ll usually save money when compared with buying a move-in ready home, even when taking into account the cost of the repairs. This can be a great way to get into your dream neighborhood.
Renovations can add value to your home, helping you to quickly build up equity.
Curious about which types of renovations provide the best ROI for fixer uppers?
Good: Additions that bring the house in line with its neighbors, such as garages, decks, or additional bedrooms/bathrooms. Such projects usually cost as much as or more than they return in market value.
Better: Kitchen and bathroom remodels, new lighting, etc.
Best: Painting, refinishing floors, stripping wallpaper, new windows & doors, etc., which generally cost much less than what they return in market value.
You have the opportunity to turn a house into your dream home and do things just the way you want them, without having to compromise or wait years.
There’s usually less competition for these homes from other buyers.
That said, buying a fixer upper comes with its own set of challenges.
There is a big difference between cosmetic & structural fixes when it comes to fixer uppers. Major structural repairs and foundation fixes hardly ever raise the value of the house enough to fully offset the cost of the renovation, so it’s important to calculate your project budget in advance, rather than just assuming you’ll make the money back.
People who fix and flip homes for profit are very calculated in their decisions: which home to buy, where, which repairs to make, DIY or contractor, etc. The average homeowner shouldn’t assume that they’ll be able to make money off of a fixer upper, especially if they’re hiring a contractor to make repairs.
The Challenges of Financing a Fixer Upper
A big challenge in financing a fixer upper is calculating the total cost of the project to make sure you’re not losing money before putting in an offer.
To do this, you’ll want to start with a budget totaling the costs to renovate your property based on a thorough analysis of the condition of the home - including materials and labor.
Next, you’ll want to subtract that from the home’s estimated after renovation value + 10% of the renovation cost for unforeseen extras and mishaps. What’s left should be your offer.
Here’s an example:
You’re looking at a 4br/4b home nearby, and you know you’ll need to redo the floors, paint, remodel the kitchen, and knock down a few walls. All of this is going to cost around $200,000. After the renovation, you think the home will be worth about $600,000. If you subtract $220,000 from $600,000, you end up with $380,000. If you don’t want to lose money on the renovation, you shouldn’t pay more than $380,000 on the home.
However, you’ll also need to account for other hidden renovation expenses, like temporary accommodations, storage space, new furniture and interior design work, inspections, permits, and more.
Renovating an entire home doesn’t come cheap.
In fact, it’s not uncommon for an entire renovation wishlist to cost $100k or more, and the challenge that many home buyers face is financing this on top of the house purchase when buying using a traditional mortgage.
And that’s where home renovation loans come in. FHA 203k, Fannie Mae HomeStyle or construction loans have traditionally been the only financing options when buying a fixer upper given that home equity loans require tappable equity, meaning the average homeowner would need to wait many years before being able to use this financing option to renovate. The same goes for a cash-out refinance.
But as we’ve already mentioned, it’s no longer the case that these are the only way to be able to afford to renovate a fixer upper, and a RenoFi Loan can help you to borrow the money for the renovation and repairs. But more on that soon.
It’s still common for a 203k or HomeStyle renovation mortgage or a construction loan to be used to purchase and renovate, though, despite the complexities and delays that come with them.
Remember though, that better financing options exist, you probably just don’t know about them.
Using Loans To Buy A Fixer Upper
FHA 203k Loans, Fannie Mae HomeStyle Loans AND construction loans all let you borrow based on the after renovation value of the property.
And when used for buying a fixer upper, that means that you’re borrowing based on what the market value of the house will be once all of your planned renovations and repairs have been completed.
So let’s say the house you’re considering buying is currently worth $300k, but will be worth $450k once you’ve carried out the work, these loans let you borrow the money based on this higher value and combine the financing of both the property AND the renovation in a single loan.
These reasons alone have historically made these loans the go-to choice for purchasing and renovating a fixer upper, but there’s more. With both of these, there’s a low minimum down payment requirement.
Add to this the fact that fixer uppers are popular with first-time buyers and it’s easy to see why these loans are so commonly used.
4 Reasons Why You Shouldn’t Use An FHA 203k Loan, Fannie Mae HomeStyle Loan or A Construction Loan
We’ll get straight to it… you probably shouldn’t use a 203k, HomeStyle or construction loan to finance the purchase and renovation of a fixer upper.
1. You’re a less competitive buyer in the housing market
Imagine this scenario: a home has come up for sale on the perfect street.
Yes, the home needs a little (or maybe a lot) of work and is definitely what you’d class as a fixer upper, but a neighborhood like this in your area is too valuable to pass on.
You plan on applying for an FHA 203k, Fannie Mae HomeStyle or construction loan so you can borrow enough money for the purchase and renovation. But in the meantime, another buyer offers the same price, using traditional financing.
Who does the seller and their agent choose? Not you.
And this means that you just lost your dream home.
The truth is that a home buyer using one of these renovation loans is at a huge disadvantage in a competitive market because of the fact that they require extra steps when compared to paying cash or using a traditional mortgage.
And when you’re up against someone who can move quickly to finalize the deal while you drag out the sale bogged down by the process of FHA 203ks, Homestyles and construction loans, the odds are that the seller won’t be choosing you.
But what are some of these extra steps with these loans?
Finalize your renovation plans
Before anything else happens in the process, you have to finalize the full list of renovations and repairs you want to carry out.
And while this isn’t a process you’d typically want to rush, with all of these loans, you need these plans in place to be able to obtain the financing.
Hire a contractor
Once you’ve decided the work that you want to do, you need to find a qualified contractor for the job.
Again, not something you should rush, considering how important it is to find the right one for your project. Certain jobs may also require a licensed architect if you plan on making structural changes.
Hire a HUD consultant (For FHA 203ks and Homestyles)
A FHA 203K loan requires you to hire a HUD consultant for renovations over $35,000 or renovations with structural changes, while the same is required for renovations over $50,000 with a HomeStyle loan.
This can add weeks to the process, especially if that consultant requires any changes to your plans.
For example, not all homes are FHA compliant and if your home doesn’t meet the loan’s minimum health and safety standards, you’ll be required to make certain required repairs in addition to your own.
Keep in mind, all these steps have to happen weeks before you even purchase the home, so if competing buyers are skipping those steps with a traditional mortgage, it’s safe to say you’re already out of the game.
2. Warning: Potential for Even More Delays
On top of all these other hurdles that you’ll face, your lender could also hurt your chances of getting the home you want.
Since there aren’t any special training or requirements to originate these loans, many lenders can do it, but not all are set up to support the product, which can bog down the system.
As a result, many lenders are closing these loans in as many as 3-6 months, compared to 45 days like a traditional loan.
On the other hand, they might just try to point you in a completely different direction than the home you actually want.
3. Big Decisions, Little Time to Think
All additional work aside, no one likes making decisions under the pressure of a ticking clock.
But when you’re buying in a competitive market, using these loan types will force you to rush the process.
That means having to squeeze everything from planning all the specific details of your renovation project to shopping for the right contractor into a very tight timeline, and this only increases the risk of something going awry.
4. Goodbye Low Interest Rates & Fees
The truth is FHA 203k and HomeStyle mortgages have a number of advantages when buying a home such as the fact that they require only a minimal down payment (3% for a 203k and 5% for a HomeStyle).
But those benefits typically come at the cost of a higher rate (this is also the case for construction loans) and the requirement to pay a monthly mortgage insurance payment in addition to financing, while a FHA 203K loan adds an upfront mortgage insurance premium as well.
Because of this higher rate and fees, many homeowners end up refinancing after the renovation meaning they pay closing costs twice.
So while you’re getting the financing you need to purchase and renovate the home, you’re likely going to be paying a higher mortgage rate with higher fees in the years that follow.
What’s The Best Way To Purchase & Renovate A Fixer Upper?
If you are purchasing a home that could qualify for financing without the need of a higher rate 203K or HomeStyle loan, a smarter strategy might be to purchase the home with the lowest rate mortgage you can find and then use a RenoFi Loan to fund the renovations.
So let’s introduce you to these.
Introducing RenoFi Loans - An Alternative To FHA 203k & HomeStyle Loans
If you’re considering using either an FHA 203k, HomeStyle Loan or a construction loan to purchase and renovate a property that’s in need of a little bit of love, we think you’ll want to know all about RenoFi Loans.
This new type of home renovation loan combines the best elements of a construction loan with a home equity loan, allowing you to borrow all of the money you need at the lowest rate possible.
The main things you need to know about RenoFi Home Equity Loans are:
- You can borrow between $20k and $500k
- Terms of up to 20 years
- Ability to borrow up to 95% of your home’s after renovation value
- The full loan amount is available at closing
- You won’t need to refinance your existing mortgage
Here’s how these loans stack up against 203ks, HomeStyle’s and construction loans:
|Renovation Home Equity Loan||Single-Close Construction To Permanent Loan (CTP)||Fannie Mae HomeStyle Loan||FHA 203k (Full)||Two-Close Construction To Permanent Loan (CTP)|
|Is this a mortgage?||Yes||Yes||Yes||Yes||Yes|
|1st or 2nd mortgage?||2nd||1st||1st||1st||1st|
|Require refinance of existing mortgage?||No||Yes||Yes||Yes||Yes|
|Typical Interest Rate||Market||Above Market||Above Market||Above Market||Above Market|
|Loan Limit (Renovation Cost + Mortgage)||$500,000||Jumbos allowed||Conforming only||$Conforming only||Jumbos allowed|
|Loan Term (max)||20 years||30 years||30 years||30 years||30 years|
|Credit Score Required||640+||700+||620+||580+||580+|
|Loan to Value||Up to 95%||Up to 95%||Up to 95%||Up to 96.5%||Up to 80%|
|Can be used for building new home?||No||Yes||No||No||Yes|
|Restrictions on type of improvements?||No||No||No||Yes||No|
This alternative financing option allows you to purchase your new home with a traditional mortgage and simply finance your renovation when you’re ready.
And let’s not forget that the entire process can be stressful enough on its own, so breaking it into two steps keeps things at a pace you’re comfortable with.
That not only means staying competitive against other buyers to get the home you want, but also making all the big decisions on your own terms.
They say timing is everything, after all.
How do I know if a RenoFi loan is right for my project?
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The Importance of Choosing The Right Financing Option For Your Fixer Upper
The one thing that we want you to take away is that you have options and alternatives.
You don’t need to lose out on that home you’ve fallen in love with because of the delays caused by a 203k, HomeStyle or construction loan.
Before jumping into using one of these, contact us to discuss whether a RenoFi Loan could be right for your project and prepare you to get the home you want on your terms.